June 08, 2008 seekingalpha.coml
Dow Chemical's Liveris Interview: Part I- Oil by: Todd Sullivan
This is part one of my interview with Dow Chemical's CEO Andrew Liveris. In this part we talked about oil, natural gas and how the JV strategy will effect their impact on Dow.
Todd:
Hello Mr. Liveris
Andrew:
Hello Todd, nice to finally put a voice to the blog. Todd it has
been great reading your pieces......you track us very closely.
Todd:
Thank you. In full disclosure, I have been a shareholder for a
few years now and quite a bit of my sons' educational accounts is
in Dow stock, so I'm hoping you allow us to send them to the
private school of our choice, not forced to a state one.
Andrew:
(laughing) I'm in I'm in. This is one of the nation's core
issues, but we won't get into that, I know we have limited time.
You have very thoughtfully put together some questions forward.
Todd:
Yeah...let's get started.
Todd:
With the move in production to low cost nations underway, do you
see a day when $125 oil and $12 nat gas become earnings drivers
for the company, as the price increases you are able to push on
are in excess of input price increases? For example, say I make
finished OJ. If the prices of oranges are going up, so are the
prices of finished OJ. But, if I partner with an orange farmer,
my input prices do not rise (or if they do, at a fraction of
those buying oranges from the farmer), but I am then able to
either increase my OJ prices along with other producers, OR
become the low cost seller to increase market share. Does the
analogy hold for Dow down the road?
Andrew:
It has been an interesting phenomenon as I have watched it rise
since I got appointed. I almost feel like it's a job index, you
know, years in office and years of oil price rises. I don't think
I've seen a decline except momentarily early last year.
Nat. gas is a US regional issue but will probably become a world
issue, but right now it's still a US regional issue. Oil though
is a world issue, and to your question then, if you have rising
oil prices that are global in nature and all of its derivatives
and they go up steadily, then your point comes true. In essence,
for us it actually becomes a reason to raise prices but that is
only as good as the consumer's ability to take those prices.
Unlike the 70s, which was the last time this really all occurred
this time around, we have the Chinese consumer, and frankly that
actually adds some optimism that we should be able to, as a
globe, pay more for these precious resources in the value chain.
Now, you can't do it overnight otherwise you will kill the
consumer, but over a period of time steadily rising inputs with
strong new demand from places like China and other places (India,
Middle East, Europe etc) then I think margin recalibration of a
high oil price input all the way through the value chain
including our part becomes very, very reasonable. Actually, the
margin expansion which happened in the 70's, Dow had a whole
philosophy back then if you go back and track it, called
Reinvestment Pricing. Others used the acronym RIP and they were
having fun with us. {laughter} It really was the same scenario
but at that time the buoyant demand was more the US and that
actually became the big problem as it created inflation and
stagflation.
But this time around we have China, so there is a chance your
scenario will come to pass as long as it is not surging or a
surge up and then a surge down which creates volatility.
Todd:
When you make the move to the Kuwait and Saudi ventures, do you
see a significant input price drop on Dow's part?
Andrew:
Well, the Kuwait venture and the Saudi projects. Yes, I mean look
firstly [at] what we do there...s we take advantage of natural
gas prices way below world price and where you can see from our
financials we are already making a lot of money in equity income
from that. That is because those countries have said "I want
to diversify our economies away from just oil and gas".
We are a great diversification hedge for them, that is why they
are prepared to give us low input prices way below world price,
way below US price for sure. On oil, OK the key for us there is
I'd like to call it the Exxon model. I mean Exxon, which is
almost like nation-state in its own right, they basically take
oil at world price or they produce it at cost and when they
distribute in their production systems. They are efficient
allocators of resource to petro-chemicals to fuels of all sorts
not just gasoline and they run their whole machine for
profitability which means that net net their input costs of
petro-chemicals is lower because they run the whole machine. Now,
with Kuwait Petroleum and with Saudi Armco that is exactly the
model we're building.
We're building a refinery integrated petro-chemical model where
the owners of the oil, Kuwait and Saudi Arabia respectively, will
be able to efficiently allocate the oil within that entire
machine...[O]f course we're a half owner, [so] the shareholders
will benefit from oil integration. [S]o two physical hedges: the
gas one which is the stranded nat. gas with nation states that
want to value add the gas vs burn it and second, refinery and oil
integration with nation states who have oil who want to diversify
away from just exporting the oil or who want to take the oil to
places like China and want to participate in refineries and
petrochemicals there.
Those are great physical hedges for the Dow Chemical Co. not well
understood by the investment community. We're working really hard
to make them understand it and you know, the icing on the cake is
that we got paid $9.5 billion for that privilege.
Todd:
So, you anticipate 2010 is the year those JV's (Kuwait and Saudi
Arabia) should be up and running?
Andrew:
We are being conservative Todd. [In] my recent investor
presentation I showed 2011/2012 because stuff happens you know,
TPC contracts capital costs etc. We're pretty good as project
managers and so are our partners, so conservatively we are saying
2011/2012.
Dow Chemical's Liveris Interview: Part II- Energy Policy
In this section Mr. Liveris and I discuss US energy policy (or lack thereof):
Todd:
US energy policy. I had several questions planned here but you
have been all over TV the last week and a half answering them for
me...
Andrew:
(Laughing) And I am not done yet, I am determined to shake this
all loose because we are just shooting ourselves in the foot very
effectively as a nation.
Todd:
There was an "American Energy Production Act" Senate
Republicans just introduced recently, have you seen it?
Andrew:
The drilling one right?
Todd:
Yes, they said it would produce an estimated 24 billion barrels
of oil a day and 47 trillion cubic feet of nat. gas.
Andrew:
Certainly the bill recognizes the problem. It is a Republican
bill and certainly I appreciate Senator Domenici's work on it.
However, the country needs a bill both Democrats and Republican
can support...
I was in Washington yesterday and I had meeting after meeting. I
actually think I might get deported here eventually [laughter] .
You know I'm just screaming from the rooftops to get real with
our energy policy.
Todd:
Let's say you left Washington and they said "this guy is
right, let's do everything he said we should". Even if they
did that and they started at the earliest next spring, after the
election, what kind of lag based on your experience? Is it 2
years, 5 years before anything they do now actually takes hold
and excess production comes online?
Andrew:
Well we went through this in 2005 with the Lease Sale 181 in the
inter-continental shelf of the US. The US gulf we were told that
time and I think this is still very true that there are some
known fields of oil and gas that can easily be tapped into
current infrastructure especially on the US gulf, they could be
on the street in 12-18 months. Not as big as the numbers you just
quoted, because on the outer edge that would be Anwar and that
could be as far away at 4-5 years because of the pipeline.
We take a window and if you said "let's go now" I think
the earliest is 18 months and the latest is five years. But
something else happens which is very important. The world as
speculators look at supply very differently. We have a real
supply issue because demand is surging and everyone thinks that
there is not enough supply. Supply is bottle-necked in two
places. One is availability of actual oil and gas; of course, in
our country we're not accessing it and it will take 18 months to
five years to accomplish that. Overseas its ships and freight and
there are not enough ships on the water to get all this oil to
everyone to get all this gas to everyone. So that's one
bottleneck.
The second bottleneck is refining capacity, which as you know
this country won't permit refineries. I think the only one under
construction today is Valero in Texas. No one wants a refinery in
their back yard. So you have this ridiculous situation of
Reliance building the world's largest refinery in India and all
the products are for exporting to the United States.
So those two bottlenecks will take several years, if you take
those two bottlenecks out by passing laws, I think there will be
an instantaneous reaction to price.
Dow Chemical's Liveris Interview: Part III- Agriculture
In part
three we discuss Dow Ag and the agricultural sector in general
including DuPont and Monsanto.
Todd:
Roughly a third of earnings in the most recent quarter were Dow
Ag. After you sell the commodity business, we are looking well in
excess of that. I have not been able to find what percent of
future earnings you expect them to be and what type of growth and
how far out, as right now you are at about 20-25% annual EPS
growth at Dow Ag. Going out 2009-2010 and beyond, to me 20% -25%
EPS growth there seems sustainable if not surpassable. Accurate
or not?
Andrew:
I think you are more accurate than not, remember the current % of
Dow earnings is because AG is front loaded. It tends to be a
first half year event for all of us because we are in the
northern hemisphere and that's whether its Dow, DuPont or
Monsanto. The whole year happens in the first six months. We have
some southern hemisphere exposure, notably Brazil and Argentina
and my country Australia, but most of it is titled towards the
northern hemisphere as a % of total earnings. Those numbers are
distorted at this moment, but if you take the whole year and you
say in '07 Dow AG earned about 10% to 15% of Dow's earnings but
their growth rate was like you said, 20 some odd percent for the
last five years.
They achieved that through 2 mechanisms one of which will
continue to be a big plus that will ultimate if not continue that
20% ramp up it will get very close. The first mechanism is we
have been levering Dow's considerable operational efficiencies
over to Dow's Agroscience. Even though it is a small co. $3 to $4
billion in revenue, it has the power of a $50 billion co. in
terms of operational excellence in its manufacturing, plants and
supply chain. In its governance and share services it operates
with its access to big company infrastructure, that's number one.
That's helped a lot of the cost line. Number two, the most
exciting part is its pipeline. I mean, four years ago we made a
conscious decision we said,"look, we're never going to be a
big seed co. because its too expensive, one of these days we
might be able to find an answer on U.S. corn, but between now and
then let's rev up the technology engine and frankly not just in
bio and seeds and traits in germplasm, but also in crop
chemicals." I don't care what people say, GMOs will not
replace crop chemicals in totality because growers will always
need variety in their toolbox, its about diversity of solution
and biotech cannot answer everything.
So we said "let's put R & D in focus on the pipeline
that we now have" in crop chemicals in particular things
that are not just in corn, but outside of corn, in cotton,
rapeoil and canola, in seed ,in soy beans and of course over
range and pasture. The crop chemical R & D pipeline we have
right now and what we have done in traits, and in particular our
new traits that we have announced plus the SmartStax agreement
with Monsanto, have put us in a tremendous position. By 2010 when
SmartStax gets launched, when our new traits get launched and our
crop protection pipeline comes through, the R & D engine will
yield real margin expansion for Dow AG.
I happen to think that Dow Ag in many ways doesn't need to have
big revenues because its margins at 16%, 18%, 20% bottom line
margins is packing a big punch in terms of its ability to deliver
margin despite its size. We're increasing the R & D spending
there. Dow Ag has a quarter of the R & D spending as a
company which is a phenomenal statement when considering the size
of the company we are and out there in the future Todd, we might
be able to find rationalization opportunity and I will say out
there, we'll find another one. In the meantime keep making that
growth story.
Todd:
That was actually the next question. Ag sector valuations are
stratospheric just now.
Andrew:
Oh yeah, I mean look, what were seeing now of the whole food
change now started by corn and ethanol, that whole thing. Having
said that, we're seeing China, this whole point about China's
surge and as the Chinese eat more protein, eat more animals,
those animals have to be nutured on agriculture, agriculture
comes from feed, feed comes from corn and you know, there you go.
The food price things is real because of China's assention and I
do think that's going to get worse before it gets better and I
think the world is going to have to address it. I do not know
what the systems will be. I do think the poverty side of it is
big. The agricultural sector and the commodity boom in
agriculture is compelling valuations to stratospheres, I mean
Monsanto is the great flag carrier there, they are doing great
and it wasn't long ago they were on their knees.
Dow Chemical's Liveris Interview: Part IV- M&A
In part
4 we discuss areas of potential value for M&A.
Todd:
So, if there is no value in Ag, and no real value in the Petro-
chemical sector now, where do you see value?
Andrew:
Well, great question. Firstly, the US economy, and the housing
crisis leading to the credit issues leading to, if you like, the
financial sector meltdown interestingly enough has not yet
pitched profits in the economy in the main, apart from the banks
and financial service companies. Main Street has survived the
financial issues and the housing crisis pretty well. That means
equity values have not come down so, one, equities are not at 52
week highs but they are roughly 80-85% of 52 week highs. Two, US
dollar based companies with the US dollar , oil, interest rate
issues, overseas properties become very expensive.
So, first you have Ag expensive, Petro-chemical it is not
necessarily a question of price but of quality. Most of them are
not high quality properties and are privatized and run for cash.
The quality properties we are JV'ing with them, the previous
point. So really, if you are on the acquisition trail, US
equities have not come down a lot, and overseas properties are
expensive.
So, you know we're being incredibly, we're scutinizing
everything. I mean I don't quite have a NASA control room here,
but on my desk in my room I've got stacks and stacks of tracking
mechanisms to see when good, quality properties may become
affordable enough that we could make more money with them being
part of Dow... we could make more money with them than their
being on their own. Now, whether they are friendly or hostile,
that is another whole conversation. The fact that we haven't done
any big deal suggests those numbers aren't in target right now.
The financial discipline we've put in place here, Todd, is
something I am real proud of .
I think, you know, money's not burning a whole in our pocket and
as I've said to investors over and over, were making all the
deals we need to make and if we get to the point where we have
too much cash, a great problem to have in this environment, we'll
for sure bump up the reward to shareholders and keep increasing
our R&D spending so we can do more at Dow Ag and mimic their
success. We got a ton of R&D projects that are very promising
and then do small bolt on acquisitions, we've done 20 in the last
24 months.
At the right moment, maybe equities will come down and on our
radar screen are a dozen or so properties that when the time is
right, we'll move on. But, you know, methodic, systemic,
discipline, really paying a lot of attention to the criteria that
matters for success. Creating a winning growth company. I'm
really dedicated to putting down the earnings growth profile in a
different place and doing it in a very methodical precise way. If
I am blessed to have this job for as many years as I possibly
could given my age, I'll see it through.
I'm not going to knee jerk around to people telling me to do
short term things. That is easy to say when you're on the
outside. Trying to create long term earnings growth, that's a
different story and we're putting in place the discipline to do
that.
Todd:
Yeah, just from a personal standpoint I have not been able to
understand the media's infatuation with you having to do
something. I'd rather do nothing than something stupid.
Andrew:
(Laughing) Unbelievable how the English language causes the media
to go to strange places. If I could put your headline on every
analyst report, I would.